Negative equity: what does it mean and how can I avoid it?

You can come into problems if your home doesn’t hold its purchase value over time – and it can put you at risk of negative equity. This usually happens when property prices fall, and first-time buyers are most likely to be impacted.

But when does being in negative equity become a problem and can it prevent you from remortgaging? Here we look at negative equity in closer detail, including how to avoid it where possible.

What does negative equity mean?

Put in simple terms it means your home is worth less than your mortgage. In other words, if you sold it, you’d still owe money to your lender.

Karen Noye, mortgage expert at advice and wealth management company Quilter, says: ‘In a nutshell, negative equity is when the property you purchased ends up being worth less than the mortgage you took out on it.’

If you have equity in your home, that’s the percentage you own. If you have zero equity, you don’t own any of it. Negative equity means you owe more for the property than it’s worth.

For example:

• If you bought a home worth £200,000 with a £10,000 deposit, the mortgage is worth £190,000. Your equity is 5 per cent.
• If house prices fell, and your home was worth £180,000, you’d still owe £190,000 on the mortgage. Your equity is minus 5.6 per cent.

It can be a particular worry for first-time buyers who usually have a smaller slice of equity compared to homeowners who have been repaying the mortgage for many years.

What's important to note, is that negative equity isn't the same as falling house prices. Your home can lose value, but you're only in negative equity when it dips below the outstanding mortgage balance. It’s a poor outcome for homeowners, but it’s not necessarily the death-knell of homeownership.

Some people won’t be impacted badly. If you’re happy in your home, and can still afford monthly repayments, you can wait it out.

Scott Clay, of specialist lender Together, says: ‘It might only be a moment in time. If house prices rise in future, and your house increases in value, then you will come back out of negative equity through the natural ebb and flow of the UK property market.’

When is negative equity a problem?

It becomes and issue if you need to move house or change mortgage deals. Some homeowners will only find out they’re in negative equity when they try to sell their house or remortgage.

When you want to sell, you'll need more money. Enough to settle the mortgage with your lender, and for a deposit on a new home.

Noye says: ‘This lack of flexibility can have big consequences, particularly for younger buyers. They're more prone to changes in circumstances such as needing to relocate for a new job. Or needing extra space for a growing family.’

It can also prevent a problem for couples who want to separate. They can’t stay together but can’t afford to sell either.

If you pay an interest-only mortgage you could struggle, because you haven’t built equity in your home. At the end of the term, you have to pay the original property purchase price. If you need a new mortgage this will be difficult while in negative equity. If you sell, there won’t be enough money raised to pay off the final bill.

Do I have a chance of remortgaging?

If you’re in negative equity, your lender won’t offer you a cheaper deal when your existing mortgage rate ends. Neither would one of its rivals. You’re likely to move on to your lender’s standard variable rate, which is usually more expensive.

If you have enough savings to lift yourself out of negative equity and provide a deposit, then you could remortgage.

For example, if you're in negative equity by £5,000, you need that sum of money, plus however much is required as a deposit on a new deal. Movers might be able to secure a special ‘negative equity mortgage.’ This allows you to transfer your situation to a new property. But it’s likely to be an expensive deal and you should seek advice from a mortgage broker first.

Is there anything I can do to avoid falling into negative equity?

If you’re looking to buy a home, a bigger deposit helps so you don’t overstretch yourself financially.

If you’re already a homeowner, then overpaying the mortgage can help. The more equity you build up in your home, the less of a threat negative equity is to you.

Clay says: ‘Mortgage lenders typically allow borrowers to overpay their mortgage by around five to ten per cent of the outstanding debt each year. ‘This can be a sensible use of any disposable cash.’

Ultimately, a shrewd property purchase, more money, or a wait-and-see approach will prevent negative equity from becoming too much of a problem.